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The funds of hedge funds that are too hot to handle

End investors and hedge fund managers are increasingly concerned about those funds of funds that take a hot money view, rapidly switching cash in and out of hedge funds. Some of the horror stories risk tainting the entire industry. Helen Avery reports.

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“EVERY HEDGE FUND manager I speak to has at least one ‘hot money’ fund of hedge funds horror story,” says a fund of hedge funds executive. Horror stories are indeed plentiful. “We’ve all heard the story of the hedge fund that went from $100 million to $1 billion in a year, and then back to $100 million a year later due to funds of hedge funds inflows and outflows,” says Adam Sussman, senior research analyst at Tabb Group. This short-term view of parking money and pulling out is becoming a bugbear among hedge funds, which are increasingly turning away fund of hedge funds money.

There are 2,071 funds of hedge funds in HFR’s database alone. Three years ago there were 1,232. Their combined assets under management total $426 billion – one-third of the estimated $1.2 trillion in hedge funds, and market participants suggest these figures are conservative. It’s a huge industry, founded on the principle that funds of hedge funds can do a better job of picking hedge fund managers, diversifying returns and gaining access to high-quality funds than an individual investor can. But recent events indicate that this is not always the case.

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